Back On Track

A revival in the commercial vehicle segment and healthy growth in its car sales will hold Tata Engineering in good stead

There's optimism in the air. Commercial vehicle sales is picking up. And this spells good news for the country's largest truck maker Tata Engineering. According to data from the Society of Indian Automobile Manufacturer's Association(SIAM), the 23 per cent drop in commercial vehicle(CV) volumes in FY01, has been plugged by a 2.5 per cent growth in FY02.

Tata Engineering, with a 68 per cent marketshare in Commercial Vehicles(CV) recorded a nine per cent growth in volumes in FY02. The company has sold 4985 units of Medium and Heavy Commercial Vehicles(M/HCV) in the month of May 2002 -- nearly double of what it sold in the previous corresponding period. Considering the company's current showing, it seems to be on track to achieve the projected five per cent volume growth in the CV segment for FY03.

 

Tata Engineering is today leaner that what it was a year ago. In the event of tough market conditions, and changes in the demand dynamics of the commercial vehicles(CV) market, the company took various strategies to adapt to the changing environment and grow profitability. Value creation strategies including cost reduction activities, balance sheet rightsizing, and focusing on higher growth product categories have helped the company in the turnaround process.

Operational restructuring: The company has reduced cost to the tune of Rs 628 crore over the last two years. Nearly Rs 400 crores has been saved in material costs and vendor rationalisation. Number of vendors have been slashed from 1100 to 700 over the last two years.

It's likely to be pruned to 500 over the next two years. Raw material as a percentage of net sales have declined 520 basis points in the last fiscal. Thanks to the increased usage of e-commerce and reverse auctions for the procurement of components and services, it's expected to dip even more. Also, the company has been progressively shifting towards its own 697 series of engines instead of the costlier Cummins engines.

Financial re-engineering: Financial restructuring and tighter working capital management has helped the company reduce capital employed by a massive 51 per cent over the last three years.

Significantly, the company's net working capital has been reduced from 112 days in FY98 to near zero in FY02. "The company will now be able to deliver better return on capital and will be a value creator" say analysts.

Over the past three years, the company has reduced its level of vertical integration by hiving off various manufacturing divisions into subsidiaries, stakes that could subsequently be sold to strategic partners. It has divested financial assets to reduce its debt level. Borrowings have come down by a third over the last three years, and costly debt to the tune of Rs 372 crore has been pre-paid in FY02.

Consequently, Tata Engineering's gross interest over the last two years have declined 27 per cent to Rs 395 crore. Clearly, all this has helped in improving margins. The operating margin increased 380 basis points to 10 per cent in FY02. Thus cash break-even level has come down significantly. For Indica, it has reduced from 70,000 in FY01 to 53,000 in FY02 and for CVs analysts expect it to decline to 65,000 by FY04, much lower than 100,000 units in FY97.

More car per car: Tata Engineering's car project -- the Indica, is no longer perceived to be a threat. The improved version of the Indica, the V2, has dispelled all concerns. The company's passenger car segment grew 46 per cent to 64,036 units, much higher than the 10 per cent segment growth. According to the company, its market share grew a healthy six per cent to 23 per cent.

Operating margins on the Indica has surged from two per cent in FY01 to seven per cent in FY02. Analysts are hopeful of a net break-even this fiscal.

Going forward, the company intends to leverage on Indica's success. It will launch three new variants of the model, and exploit export opportunities. All put together, analysts estimate Indica to grow volumes by 30 per cent to 85,000 units this fiscal.

In the LCV segment, the company has tried to combat falling sales by introducing new variants. Albeit on a small base(2245 units), the company has registered a 49 per cent rise in volumes in May 02. This fiscal, analysts expect a incremental growth of 2-3 per cent in this segment for the company.

The company is consolidating its presence in the UV segment by launching upgrades and variants of the Safari and Sumo to strengthen its presence in the respective segments. If this strategy succeeds, Tata Engineering will arrest the degrowth in the UV segment. While this segment registered a four per cent decline(3,587 units) during the first two months of this fiscal, analysts expect the segment to register a positive growth this year.

The company is trying to increase contribution from non-cyclical businesses to 16 per cent this year, up from 14 per cent currently. Financials and valuations: Tata Engineering's financial performance for the fourth quarter of the last fiscal has been quite impressive. Net sales at Rs 2586.8 crore rose 18.59 per cent. Even as operating profit rose from Rs 106.3 crore to Rs 292.24 crore, margins surged to 11.3 per cent from 4.87 per cent in the previous corresponding quarter.

After seven consecutive quarters of net losses, the company posted a net profit of Rs 161.68 crore in the fourth quarter of FY02, thus wiping away much of the Rs 215.41 crore loss incurred during the first three quarters.

Cash flow from operating activities rose by 26 per cent to Rs 868 crore, thanks to cost efficiency measures undertaken by the company.

With incremental volume growth and more cost efficiency measures, the company expects to effect fixed cost savings of Rs 150-200 crore in FY03. Says Kalpesh Parekh, analyst, Sushil Finance Consultants: "We expect operating margins to improve by around 110 basis points to 11 per cent this fiscal".

According to analysts' consensus estimate, Tata Engineering is expected to register an EPS of Rs 8.5 in the current fiscal. The current market price of Rs 156 discounts forward earnings by around 17.33 times, as compared to Ashok Leyland's 9.4 times.

With almost 80 per cent of the company's revenues coming from sales of trucks, Tata Engineering has always grown at a faster clip in the event of a cyclical upturn. During the last cyclical upturn in 1995-97, Tata Engineering's net income rose 55 per cent as against Ashok Leyland's 33 per cent.

With the company's car project no longer a cause for concern, and the M/HCV segment appearing to be at the beginning of an uptrend, the scrip provides an excellent investment opportunity.